Risky business – replacing or retaining cover

One of the challenges facing risk insurance advisers when they review a client’s portfolio is whether or not to cancel existing cover and replace it with something different or retain the existing cover and top up the cover with an additional policy.

The risks associated with the replacement and retention of business have been reasonably well documented. However, to date, there has not been any comprehensive analysis of the risks associated with top-up cover.

For example, Mark has a risk insurance policy with one insurer. However, he needs additional cover and decides to take out a second policy with a different insurer. Are there potential issues associated with the presence of two different policies that might be material to the advice provided to the client?

Definitions and benefits

The most obvious area of difference is in regards to definitions and benefits.

If the first policy defines the criteria for payment or the nature of the benefit payment in a way that is different to the second policy, there is always the chance that one policy will pay a claim while the other will not.

This could be both confusing and annoying to the client, who may feel compelled to vent their frustration in the direction of the adviser.

Offsets

Income protection insurance policies in particular provide for the benefit amount to be reduced or offset by payments the insured receives from other sources, as listed in the policy document. However, not all policies include offsets for the same ‘other payments’.

For example: ‘Your benefit will be recalculated if you receive other payments by way of workers’ compensation or similar legislative benefits, other disability, group, sickness or accident insurance cover.’

Compared to: ‘A reduction will only be made if the life insured receives other payments through any other individual or group disability income insurance; or workers’ compensation, common law or statute (except sick leave) where such payments are in respect of the disability of the life insured.’

To further complicate matters, some companies have a different basis for calculating the extent to which an ‘other payment’ will be offset. For example, some provide for the full amount of the ‘other payment’ to be offset while others only offset to the extent that the ‘other payments exceed 10 per cent of pre-disability earnings’.

Maximum benefit payable

It is not unusual for contracts to limit benefit payments to, for example, 75 per cent of pre-disability earnings (PDEs).

If there are two policies in force on the one life insured and both have the same definition of PDEs, there should not be any problems.

However, if the definitions of PDEs differ, complications could set in.

If PDEs is defined as the 12 consecutive months immediately prior to the disability, this may give rise to a PDE amount of $9,000.

On the other hand, if PDEs is defined as the highest 12 consecutive months in the five years prior to disability, this may give rise to a PDE amount of $14,000.

In line with this, there are two possible ways to arrive at the maximum total disability benefit payable:

(i) Add the benefit amounts of the two policies together and compare the total to 75 per cent of PDEs.

If this were done, it would appear equitable to compare the total to the ‘higher’ of the two PDE amounts.

(ii) Assume the second policy has been put in place as a top-up to the first.

If this were done, it would appear logical to pay the first policy in full (if earnings justify this level of payment) and use the second policy to top up the benefit payment to 75 per cent of PDEs.

The question then becomes, is the maximum total disability benefit payable then governed by the definition of PDE in the second policy, which may be the lesser of the two amounts?

Within the marketplace:

no contracts include a basis by which this situation would be handled;

~ there is no agreed basis even between insurers by which this situation would be handled; and

~ there is virtually no appreciation of the fact that this situation could arise.

It would therefore appear prudent, if an adviser came across thisproblem, for them to obtain the written agreement of the insurer as to what approach would be taken, with this agreement being obtained well in advance of a claim occurring.

A similar problem is encountered if there is a maximum benefit payable in regards to, for example, a terminal illness or trauma claim.

Is the maximum in regards to each policy or is the maximum in regards to both policies added together?

If the policies are with different insurers, does this affect the ability of one or each insurer to offset against the other?

Termination dates

Some insurers terminate policies on the exact age of the life insured while others terminate on the policy anniversary before or even after the pre-set age of the life insured.

This difference can have a material impact on the maximum time during which a claim payment may be made.

For example: Policy starts on January 1, 2000. Life insured was born on the December 31, 1950.

If the policy expires on the 65th birthday of the life insured, the expiry date is December 31, 2015.

If the policy expires on the policy anniversary prior to the 65th birthday of the insured, the expiry date is January 1, 2015.

A difference of up to 12 months of benefit payments.

Claim requirements

By having policies with more than one insurer, the adviser is potentially condemning the client to having to deal with:

~ multiple claim forms;

~ multiple claim requirements; and

~ multiple claim assessors.

Added to this are things such as the possibility of confusion; which company has been sent what?

Insurers who do not understand the full intricacies of giving advice sometimes question the basis of adviser remuneration.

Clients who do not understand the finer points of risk insurance might be tempted to take the adviser’s skills for granted.

Advisers who do not appreciate the hidden risks may question the issues associated with compliance and the value added by their licensee in identifying and reducing the risks associated with giving advice.

The questions surrounding replacing or retaining multiple policies are only one aspect of risk insurance advice, but they do serve to remind us why giving risk insurance advice is a matter of professional expertise in the same league as legal, accounting and medical.

Col Fullagar is a risk manager at Genesys Wealth Advisers .